Is Svenska Cellulosa Aktiebolaget SCA (publ)'s (STO:SCA B) Recent Price Movement Underpinned By Its Weak Fundamentals?

With its stock down 5.6% over the past three months, it is easy to disregard Svenska Cellulosa Aktiebolaget (STO:SCA B). It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Particularly, we will be paying attention to Svenska Cellulosa Aktiebolaget's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Svenska Cellulosa Aktiebolaget

How Is ROE Calculated?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Svenska Cellulosa Aktiebolaget is:

3.5% = kr3.7b ÷ kr105b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each SEK1 of shareholders' capital it has, the company made SEK0.03 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of Svenska Cellulosa Aktiebolaget's Earnings Growth And 3.5% ROE

At first glance, Svenska Cellulosa Aktiebolaget's ROE doesn't look very promising. Next, when compared to the average industry ROE of 6.4%, the company's ROE leaves us feeling even less enthusiastic. Therefore, it might not be wrong to say that the five year net income decline of 22% seen by Svenska Cellulosa Aktiebolaget was probably the result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared Svenska Cellulosa Aktiebolaget's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 7.2% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is SCA B fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Svenska Cellulosa Aktiebolaget Using Its Retained Earnings Effectively?

Looking at its three-year median payout ratio of 29% (or a retention ratio of 71%) which is pretty normal, Svenska Cellulosa Aktiebolaget's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Additionally, Svenska Cellulosa Aktiebolaget has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 43% over the next three years. Regardless, the future ROE for Svenska Cellulosa Aktiebolaget is speculated to rise to 4.9% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.

Summary

In total, we're a bit ambivalent about Svenska Cellulosa Aktiebolaget's performance. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.